Sunday, October 14, 2007

BUSINESS COMPETITIVENESS AND THE ROLE OF TAXES

The Tax Foundation presented the 2008 version of the State Business Tax Climate. The research is a valuable tool in comparing the level of competitiveness among states regarding the favorability of tax regime for business and capital creation. Through empirical point of view, the productive mechanisms such as investment and labor supply (link) are highly sensitive to tax rates and the level of levied taxes which businesses and individuals have to bear.

The index shows that Wyoming's tax system is best for business (link). California, New York and New Jersey occupy 47th, 48th and 49th place on the index respectively. The lesson is that states with higher income taxes stagnate in terms of the quality of the business environment. Nevertheless, taxes are an important part of state's competitive position, seeking to attract investment and labor supply. On the other hand, states with lower or zero-income tax benefit from low tax burden and business climate favorable to job creation and capital creation, thus receiving high rewards from competitiveness efforts.

4 comments:

It looks like it's not the first year Wyoming has had the first position on this ranking. It appears first on all rankings back to 2003.

Nevada and South Dakota also haven't fared badly. None of these 3 states have charged any corporate or personal state income tax in recent years - instead their sales, unemployment and property taxes vary.

Here's the question, then: do we have evidence that this favorable business climate has benefitted the states of Wyoming, South Dakota, and Nevada? Do their economies grow faster than the national average? Do they grow faster than California, New York, New Jersey?

It is true that the U.S. federal government is providing a significantly unfavorable tax environment no matter which state you go. It is true that the range in which an individual state can make the tax environment even worse is limited, because it's already so bad to begin with. It is true that this basic unfavorable environment, common to all states, is inhibiting tax competition among the states.

However, it would be encouraging to see if, even under these conditions, states like Wyoming and South Dakota can achieve relatively faster growth by offering more competitive tax policies.

Conversely, it would be disappointing to see if Wyoming and South Dakota aren't making headway despite their favorable environments.

I think the most useful figure to look at would be how Wyoming vs. New York have been doing in terms of the state equivalent of GDP.

A comparison of GSP data from 2000 to 2005 shows that the fastest growing state economy was Nevada, 31.0%, followed by Florida, 26.4%. South Dakota is 9th, 19.8%, while Wyoming is 11th, 19.2%. These states were all among the first 5 in the Business Tax rankings.

Alaska was 38th in terms of growth, 10.5%, regardless of its favorable Business Tax ranking; but the reasons may be apparent. (Who wants to be exiled to Alaska when there's Nevada?)

On the other hand, Rhode Island was 23rd, 14.7%; California was 24th, 14.3%; New Jersey was 33rd, 11.8%; and New York was 34th, 11.6%. These states were the bottom 4 in the Business Tax rankings.

So yes, based on this simple parallel, it would seem like a favorable tax regime can be correlated with significantly higher growth.

Indeed, the U.S. federal tax code is onerous. In fact, the U.S. federal government maintains one of the highest corporate tax rates in the industrialized world.

There is actually a positive correlation between lower tax rates on sources of productivity and significantly higher growth rate.

The fact is empirical and practical. In fact, pro-growth tax policy comes from experience and experience comes from bad policies. From an international perspective, this is obvious. Just recently, Brendan Walsh and Hannes Gissurarsson presented their studies on two economies who were riddled by stagnation and have learned a lesson from the experience of anti-growth tax and economic policy: Iceland and Ireland. I warmly recommended the viewing of those two presentations (http://www.skattamal.is/smallstates/index.php?gluggi=blod)

In the U.S., there is a larger degree of heterogeneity among the states and thus macroeconomic and fiscal impact has a higher degree of influence on the overall economic performance.

As the data shows in a genuine way, states with more favorable tax regime for entrepreneurship and productivity, sustain higher growth rates than states with a more punitive tax regime; steeply progressive tax rates and high overall administrative productivity costs.

In addition, there is a bulk of practical and empirical evidence about the negative side-effects of extensive taxation on growth, such as high property taxes and non-salary labor costs. Just recently, Rhode Island imposed a flat tax to discourage brain-drain and capital flight (http://providence.wliinc2.com/wallstreetjournalarticle.htm). True, Rhode Island is the least competitive state for productive behavior according to Tax Foundation's annual research on State Tax Competitiveness.

Above all, there is a large degree of confidence in this case, as there is a strong data evidence showing the negative feedback between high level of taxation and competitiveness and growth.

What is oftenly missed out is the microeconomic impact of corporate tax, external cost pressure and regulatory, administrative burden levied on businesses. Just take a look at property taxes. In the beginning, the taxation of property reduces housing demand. The latter nails up the investment of the construction sector and deterriorating the supply of availible housing and thus, increasing the price level. The decline in investment of the construction sector, causes the cut of production which falls out of the GDP and reduces growth potentials respectively.

Thank you for providing those useful and important data about growth rates in separate states.